Widening trade deficit a worry to US Fed official

The US trade deficit will widen before it narrows and that's a concern over the long run for the economy, said William McDonough, president of the US Federal Reserve Bank of New York.

"If I have a worry, it is the prospect the current account deficit will resume growing," he told the National Association for Business Economics, meeting in Washington. "While capital continues to flow, the capital cannot flow indefinitely. The law of gravity prevails."

The current account gap represents money the US has to borrow overseas to pay for all the goods and services Americans import and to finance investment not covered by US savings.

Until the recession trimmed US imports, the deficit had been rising for a decade.

If the current account gap does persist in widening, it would probably cause the dollar to weaken, economists say.

The dollar is hovering near a record high against a basket of currencies from the largest US trading partners. The dollar is 5.2 percent higher than it was at the start of last year, and was up 6 percent at the end of January, according to the trade-weighted index produced by the Fed.

McDonough suggested it's possible the dollar will fall.

When economists compare purchasing power in the US and Europe, the dollar is "somewhat overvalued," he said. When US productivity rates are compared with Europe and Japan, the dollar "is a little overvalued, but currencies can stay a little overvalued and undervalued for quite some time," he said.

For all last year, the current account deficit amounted to about 4.1 percent of the US$10 trillion US GDP.

While that's down from about 4.4 of GDP in 2000, it's up from about 2.5 percent in 1998.

McDonough's comments on the trade gap echo those of Fed Chairman Alan Greenspan.